Download Impact of the First World War

LECTURE 13: LATIN AMERICA FROM 1913 TO 1950
The previous lecture attempted to demonstrate that before the First World War the Latin American economy grew
relatively strongly on the basis of supplying primary products to the rapidly developing industrial markets in
Western Europe and North America. At the same time, however, there were some problems in this pattern of
development. Exports grew vigorously but the techniques of production were relatively stagnant. In the non-export
part of the Latin American economy, signs of economic development were equally scarce. That part of agriculture
that supplied the domestic market found it difficult to respond effectively to rising population and wealth, and the
handicraft industries also failed to respond powerfully to the invasion of their markets by cheap imports from the
industrialising countries. I also attempted to set this material within a framework of the debates between
dependency analysis and its critics. It is possible also to view the period from the First World War to the middle of
the century through the same window. The most famous of all dependency analysts, André Gunder Frank,
famously argued that the Latin American economy began a more positive pattern of autonomous industrialisation
and development when the ties between periphery and metropole were weakened after 1914 by two world wars
and the interwar depression. However, Gunder Frank wrote before Latin American economic statistics became
available, and his analysis rests heavily upon a fairly unenlightening discussion of what “autonomous” might
actually mean. But this period to 1950 is a fascinating one. We have already seen that this was a period of
relatively good economic performance but in the context of hugely unfavourable conditions for economies that had
previously chosen a path of integration into world markets. I aim to look at the period in the most dispassionate
way and attempt to do little more than establish the main landmarks on this route from 1913 to 1950.
Impact of the First World War
The obvious place to start is with the outbreak of war, which was marked by almost no fighting but by a major
financial crisis in the City of London. It is difficult to exaggerate the disruption that the financial crisis brought to
Latin America. Latin American governments and businesses could not get credit or payment for goods in transit.
There was a crisis in London, but in Latin America there were major bank failures, panic measures as national
governments attempted to shore up their own financial systems and immense social and economic dislocation. This
immediate crisis dissipated as governments came to terms with the disruption of their financial systems, but more
damaging and longer-run problems took their place. On the negative side, access to the German market was
impossible for the duration of the war. Access to shipping to get goods to Allied markets became much more
difficult, as shipping space became an immensely important strategic commodity and was increasingly directed to
the priorities in the allied war effort. It was virtually impossible for any country to get insurance for goods
conveyed by sea for the duration of the war, and so exporting to Europe and even to North America after 1917
became a risky and potentially very costly business. Finally, the commodity pattern of European demand changed
enormously. The British and French governments did not classify coffee as a major import priority, and so refused
to make shipping space available and dealt a body blow to the export industries of Brazil, Venezuela and some of
the smaller nations. The weakening of the export economy had a severe impact on the domestic economy of the
hardest hit nations. With lower export earnings, transport, commerce and other related activities stagnated, causing
unemployment to rise and incomes generally to fall. At the same time, the volume of imports fell, leading to big
price rises for some goods and led to inflationary pressures and this combination of rising prices and rising
unemployment stimulated intense social conflict in a number of countries.
However, not everything was quite so bad. The war damaged Latin American access to Europe, but it also
saw the rise of US economic and political influence in the region. The USA had already marked Latin America as
an area in which its influence might be strengthened even before the outbreak of war. By 1913, the USA was the
dominant external economic and political influence in Central America, most of the Caribbean and the northern
states of South America. The completion of the Panama canal in 1914 allowed increased US trade with the west
coast of South America and by 1927 only in Argentina was the US share of trade smaller than the British, and then
by only a small margin. Indeed, the weakening of British influence and the rise of American offered some help to
Latin American governments in developing the productivity and efficiency of their export industries. US capital
was much more interested in manufacturing, plantations and the extractive industries than Britain had been, and
was prepared to bring machinery and productive equipment into Latin America to further these goals. The USA
did not however provide a market for foodstuffs to anything like the same extent as did Britain before 1931. The
interruption of links to pre-war markets was also less of a catastrophe than it appeared in the first months of war.
Although demand for coffee fell dramatically, new patterns of demand emerged as the war progressed. Brazil, for
example, was badly hit by the falling demand for coffee, but its other exports (sugar, rubber, manganese, chilled
meat, etc.) did relatively well during the war. For Argentina and Peru, wartime demand was quite strong, once the
initial dislocation had been overcome and shipping became easier. Finally, rising import prices and general
shortages of supply gave a boost to local production and the foundations of import substitute industrialisation.
Contrary to the dependency school’s assumptions, manufacturing industry seems to have become
established in Latin America well before the outbreak of the First World War. In Argentina, for example, the best
estimates suggest that manufacturing contributed one-seventh of national income at the turn of the twentieth
century, and maintained that proportion to 1914 even though exports grew rapidly. A significant part of Argentine
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manufacturing was indeed directly related to the export economy in the form of meat-packing and flour milling. In
Brazil, on the other hand, import-substituting industrialisation had already begun in the production of simple
products like clothing, footwear, matches, soap, beer, cigarettes and other cheap processed foodstuffs. In fact,
export-processing and import-substituting industrialisation was also evident in Chile, Peru and Colombia before
1914. This was, moreover, factory-scale manufacturing, and not simply handicraft or domestic production. The
main beneficiary of the rising prices during the war was undoubtedly the textile industry and other aspects of
import-substitution, but the full impact of war on the Latin American manufacturing sector has to take account also
of the adverse impact on export processing, which in some countries, notably Argentina, was substantial. This
inevitably means that the impact of the war on manufacturing was patchy, and depended much on the precise
pattern of industry established in 1914. The real problem was that the impact of war on the export sector dwarfed
that on manufacturing, with the result that the growth of aggregate demand slackened and unemployment rose. As
unemployment rose, the higher prices of imports meant that inflation also rose and real wages declined. This is not
a solid base for import-substituting industrialisation, and the real surprise is that manufacturing was able to expand
at all in such difficult conditions.
The Rise of US Political-Economic Power in Latin America and Industrialisation
After the war, the industrialisation of Argentina, Brazil, Chile and others proceeded roughly in line with the
development of the social infrastructure, which permitted cheaper, more extensive transport links and greater
urbanisation. All these factors created a friendlier environment for industrial development. The extent of progress
was once again patchy, with much depending on the economic condition of the major export industries. In this
respect, Brazil enjoyed reasonably favourable conditions. Coffee remained Brazil’s main export industry and the
success of measures to stabilise prices in the early 1920s by limiting export supplies not only gave the industry
some much-needed stability but also tended to encourage resources to shift out of the industry. Brazil had
relatively strong tariff protection to make the domestic market relatively safe, and a number of international
companies undertook foreign direct investment in the Brazilian economy. US firms in motor vehicles, sewing
machines, paper products and rubber tyres established branch plant in Brazil behind the protective tariffs. In the
process, US influence in the country was consolidated and that of Britain continued to wane. Perhaps as a result,
imports of capital equipment expanded quite rapidly in the 1920s and the foundations for more extensive
industrialisation were quite firmly laid. However, these very positive signs were to some extent counterbalanced by
problems in Brazil’s largest manufacturing industry, cotton textiles, and economic policies that periodically
sacrificed domestic expansion to the needs of stabilising the rate of exchange. The main problem for cotton textiles
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was that the international market became much more competitive. British producers lost much of their market in
India, and so were searching for replacement sources of demand; US cotton textile production was beginning its
shift from the northern states to the low-wage, high volume system in the South; and the Japanese were developing
their own version of high volume, cheap-labour production. This sort of intense competition pushed down prices
that Brazilian producers found uncomfortable, even despite their high tariffs. The tight domestic economic policies
were intended to make Brazil seem a more attractive venue for foreign investment, but they had the effect of
hobbling cotton textiles even more, as it struggled to reduce costs to meet foreign competition. Industrial
production rose by an average of approximately 2 per cent per annum during the 1920, but industrial production
excluding cotton grew at more than twice this rate.
Policy Innovation in Chile
Quite similar patterns are evident in Chile, where the government after the war tried to develop its manufacturing
base by raising tariffs, the classic first step in ISI. Indeed the Chilean government also devalued its currency, which
was a further measure to ensure that domestically produced goods would become more competitive with imports.
The Chilean government also established a number of bodies to provide financial support to domestic
industrialisation and in some cases to undertake commercial activities on behalf of the new industries being
established during the 1920s. Chilean industrialisation has a double aspect. On the one hand, the fastest-growing
industry was cotton textiles, which is totally consistent with the normal pattern of a country beginning to
industrialise. However, the second most rapidly-growing sector was metals and machinery, which reflected the
government’s preference for a rapid broadening of the industrial base of the Chilean economy. This sector suffered
a very severe contraction during the world slump of 1929-32, but rapid recovery as the Chilean economy began to
recover in the middle 1930s. This is what you might expect of an industry, like metals and machinery, which
makes investment goods. The investment cycle is inevitably more disturbed than that for consumer goods of for
the aggregate economy, but the Chilean government continued to raise tariffs throughout the slump as it tried to
keep the domestic economy protected from international slump. As a result, the Chile produced 70% of its total
needs of metals and machinery, compared with about 30% in the later 1920s. To Latin American economists this
marks a considerable achievement and a decisive break with the vulnerable and narrower export-led pattern of the
early 20th century. To more orthodox, neo-classical economists, Chilean industry was having to pay very high
prices for what were inevitably inefficient machines and machine tools, thus weakening the competitiveness of the
nation’s whole manufacturing sector. Elements of both arguments are undoubtedly valid and the real test would be
to make these industries more competitive and efficient in the longer run.
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Argentina in the slump and after
Finally in this section on the interwar years, I want to return to Argentina and the world slump of 1929-32.
Argentina experienced weak growth in the 1920s. Manufacturing certainly expanded, but against the background
of uncertain trends in the export economy. The world slump of 1929-32 had many dimensions, but in the periphery
the most important was a trend towards over-production of primary products, especially for cereal producers,
notably of wheat. To this extent it was unfortunate in the extreme that Argentina switched even more heavily into
cereals during the 1920s, so that these products accounted for more than three quarters of all agricultural land in
1929 compared with less than half in 1920. In this process, Argentine cereal farmers became major importers of
agricultural machinery as they tried to cope with sagging wheat prices in the 1920s by producing ever more
cheaply. Unfortunately, when the crash came in 1929, they were burdened with debts and heavy interest payments
on top of their market difficulties of very low prices and huge stockpiles of unsold grains. The Argentine grain
producers certainly faced very difficult terms of trade in the 1920s and indeed in the 1930s. In this context, it is
hardly surprising that the growth of the manufacturing sector tended to be rather disappointing. Like Brazil,
Argentina saw flows of US foreign direct investment in the 1920s, but the impact was again disappointing. These
firms tended to import heavily, as they relied on the main home US plant for machinery and main material inputs
and to have relatively few linkages with the rest of the Argentine economy. In the 1920s, Argentina’s litany of
woes included suffering the classic symptoms of enclave development from foreign direct investment. All these
considerations point unerringly to a crisis in Argentina’s balance of payments at the very start of the world slump
and it was forced into crisis measures in December 1929. The Argentine economy contracted continuously until
1932, and the economy regained the level of 1929 only in 1935. You get some idea of the mechanisms from Figure
13.1 (next page), which shows the course of Argentine national income from the start of the slump through to the
start of the Second World War. There are obvious steep contractions in both consumption and investment, and both
fall further than national income, but there was a big turnaround in the balance of payments and the trade balance
became positive and cushioned the economy a little. In fact, Argentina escaped the depression relatively lightly,
which was highly unexpected given its commitment to international trade and its very unfavourable dependence on
cereal exports.
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Figure 13.1: Argentine national income, 1913-40
12000
Million paper pesos at 1913 prices
10000
8000
Trade Balance
Investment
Public consumption
Private consumption
6000
4000
2000
0
1913
1928
1929
1930
1931
1932
1933
1934
1935
1938
1940
-2000
Recovery from the Slump
The fate of other major Latin American countries is given in the table. Mexico, Chile and Cuba all contracted more
severely than Argentina, but there was an association between the size of the slump and the extent of recovery in
the 1930s. Argentina’s contraction was just below average, but so too was its recovery.
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Table 13.1: CYCLICAL INDICATORS FOR LATIN AMERICA, 1929-37
(average annual compound rates of growth of GDP)
1929-32 1932-37
Argentina
-4.8
5.2
Brazil
-0.4
7.5
Chile
-9.8
8.3
Colombia
1.3
4.2
Cuba
-14.0
14.8
Mexico
-6.8
7.2
Arithmetic average of above
-5.8
7.9
Source: Angus Maddison, Two Crises (1985), p. 19.
In all these countries, the slump arrived first in the form of falling demands for exports and all of them, except
Cuba, were forced into emergency policies to limit the impact on the wider economy. All of them raised tariffs, put
quotas on the amounts of imports that they were prepared to admit, devalued and imposed controls on the
exchange of currencies. Almost all (apart from Argentina) defaulted on the debts they owed, mainly to the UK and
USA. The real questions to ask are why did Brazil escape comparatively lightly, Argentina at about the average,
and Cuba so heavily during the slump, and why was the extent of recovery so closely tied to the size of the
downturn, in every case except Brazil?
With Argentina, the great surprise is that despite its immense vulnerability the situation was only about
average. One of the key steps was a dramatic change in monetary policy in 1931. Up to the slump, Argentina’s
monetary policy had been dominated by the idea that their domestic money supply should be determined by the
quantity of gold in the domestic financial system, and the quantity of gold depended upon the earning capacity of
Argentina’s export industries. In short, Argentina followed a policy that made the quantity of gold more important
than internal economic and social conditions. During 1931, it became clear that this policy was having a crippling
effect on the domestic economy. High interest rates were needed to discourage Argentine businesses and
consumers from purchasing imports and these same high interest rates were causing immense financial problems
for industry and commerce. This policy had been at the core of Argentine policy for decades because stable
exchange rates and a very conservative monetary policy enhanced the country’s ability to borrow from the
international financial markets. Significantly the official in the Ministry of Finance who almost single-handedly
brought about this policy change was Raul Prebisch, later one of the authors of the Singer-Prebisch hypothesis.
Argentina established its central bank in 1935, and Prebisch became its director of research. The change brought
about by Prebisch gave greater priority to the needs of the domestic economy in economic policy and certainly
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Prebisch’s policy of expanding the money supply helped to ensure that the Argentine slump was less severe than it
might have been. The new domestic orientation and the very high tariffs offered scope for promotion of domestic
industrialisation, just as had been the case in Brazil in the 1920s. More US companies entered Argentina in the
1930s, broadening the manufacturing base but the real foundation of import substitution was the textile industry,
again as in Brazil. Argentina’s cotton textile industry grabbed a dominant share of the market during the 1930s and
encouraged farmers to produce cotton instead of cereals and meat. However, the Argentine cereal farmers did not
do that badly in the 1930s, despite the international depression among primary producers. The Argentine
government negotiated a treaty with Britain, which gave Argentina some share in the British market at a time when
Britain was switching heavily to its own Empire for primary products. The problems of US agriculture in the
1930s, as epitomised in The Grapes of Wrath, also allowed Argentina’s farmers to expand exports, at least until the
outbreak of the Second World War.
For Cuba and Brazil there were more extreme stories. Cuba’s problems arose from three main sources.
First, its main export product was sugar, and the world market for sugar collapsed in the slump. Secondly, Cuba
was very closely allied to the US economy and US dollars had the status of legal tender within the country. This
meant that Cuba had comparatively fewer controls over its balance of payments than other Latin America
countries. It could not impose exchange controls and its ability to raise a tariff against US imports was very
limited. Cuba’s recovery followed that of the USA, but like its dominant partner the process was incomplete by the
end of the 1930s. Brazil was however a completely different story. It managed both its export and its non-export
sectors relatively well during the 1930s. As far as exports were concerned, the scheme of price support for coffee
that began during the 1920s was resuscitated as the depression unfolded and coffee prices slumped. The
government bought up and burnt surplus coffee, which brought international condemnation but some support for
the export sector. This in turn sustained domestic consumption, at least in the short term, and acted as a support to
the whole economy.
Drifting into Import Substitution
The Brazilian government, like all Latin American governments, relied heavily on revenues from tariffs on import
and taxes on export to finance its expenditure, but the collapse of foreign trade left governments in a quandary. The
Brazilian answer was to continue to spend and meet the budget deficit by borrowing and printing new money.
Interest rates were also lowered, and the potentially adverse impact on the balance of payments and exchange rate
was muffled by exchange controls. The Argentine answer had been easy money (the second part) but a completely
different budgetary policy. In Argentina, budgets remained balanced. The more radical policy in Brazil had two
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related consequences. It acted as a Keynesian-type stimulus to domestic consumption and investment and allowed
the economy to grow comparatively rapidly in the 1930s – an especially impressive result given the relatively mild
impact of the slump. This was just the sort of domestic monetary situation in which investors and entrepreneurs
were encouraged to expand industrial production. But this monetary expansion was not particularly well managed,
and it fed through as much to inflation as to additional production. In fact, the management of the export sector
was also only partially successful. The Brazilian government bought up surplus coffee to protect the growers. It
burnt some of the stock that it had accumulated, but only a small part and instead accumulated large stocks of
unsold coffee, which it released to the market slowly during the 1930s. As a result the coffee price remained
relatively depressed, and the export sector tended to stagnate during the 1930s. Thus in many of the Latin
American economies, the driving force of economic expansion in the 1930s was industrialisation, largely to
replace manufactures that had previously been imported – ISI.
The main stimulus to ISI was the change in relative prices. Tariffs and falling currency values together
raised the prices of imports, making domestic production much more commercially viable. Governments also
pursued what are usually termed easy money policies to enable domestic producers to borrow at relatively low
cost. This policy was possible only because most Latin American countries adopted fierce controls over foreign
exchange in the depths of the 1929-32 crisis. This marks a major change in political economy in these countries, a
distinct shift from an export-led to a domestically-oriented perspective. The favourable dimensions can be seen in
Table 13.2.
Table 13.2: INDUSTRIAL SECTOR INDICATORS, LATIN AMERICA IN
THE 1930s
A
B
C
D
Argentina
7.3 22.7 122 12.7
Brazil
7.6 14.5
24 20.2
Chile
7.7 18.0
79 25.1
Colombia
11.8
9.1
17 32.1
Mexico
11.9 16.0
39 20.1
Peru
6.4 10.0
29
n/a
Uruguay
5.3 15.9
84
7.0
A
B
C
D
Annual rate of growth of manufacturing net output, 1932-9
Ratio of manufacturing to GDP in 1939
Net manufacturing output per head of population in c. 1939 (in 1970 US$, converted at the official
exchange rate).
Number of workers per establishment, c. 1939
Source: Bulmer-Thomas, The Economic History of Latin America, p. 226.
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There was relatively fast industrial growth during the upswing from the depression (column A), but manufacturing
contributed a relatively small proportion of total output in all these countries. The biggest share was in Argentina,
which is not surprising since it was the richest of the South American republics. Although Brazilian manufacturing
grew strongly in the 1930s, it remained relatively small and relatively inefficient, if the figures of output per head
can be trusted. Column D shows the average size of establishments, and this confirms how small and relatively
inefficient they were.
The Balance Sheet
Inefficiency was the downside of Latin American import-substituting industrialisation. Latin American economies
could compete in producing manufactured goods only when their manufacturers were protected by very high tariffs
and by tightly controlled, depreciated currencies. The Latin American economies gained though higher
employment for the ordinary population and higher profits for the manufacturers. But consumers lost because of
the inefficiency and relatively high prices. The negative side of the balance sheet needs also to encompass major
changes in political economy that were partly stimulated by and partly reacted with the major changes in economic
structure. Nationalism became a much more powerful force in Latin American politics and society after the slump.
The onset of a major international depression is scarcely conducive to the encouragement of an international
orientation, but there is more to the rise of Latin American nationalism than this. There is a good article on the
reading list by Steven Topik on economic policy in Brazil, which shows that economic policy was never totally
oriented to the needs of the exporters between 1870 and 1940, and that the needs of the exporters began to weigh
less overwhelmingly on policy formulation after 1920. In all the Latin American economies, the export sector was
much less buoyant after the First World War than before it, with the result that unemployment levels were on
average higher and social tension more acute. In the interests of domestic political stability, more had to be done to
meet the needs of the domestic population, not least because political capital could be made from the
disappointments of the domestic population. The slump itself was bad enough, but the pressures brought on Latin
American republics by the developed countries during the depths of the depression fanned the flames of
nationalism. The Anglo-Argentine trade negotiations resulted in what is called the Roca-Runciman pact, which
was widely seen in Argentina as a sell-out of national interests and was fiercely criticised as such by right-wing
nationalists. The pressure that the USA brought on countries within its sphere of political-economic influence also
brought resentment and calls for stronger, more autonomous national development. There were major political
changes in both Brazil and Argentina early in the slump. In 1930, a military coup occurred in Brazil, which toppled
the ‘old republic’ dominated by the established land-owning elite and brought to power President Vargas. He was a
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populist and nationalist, who tried to keep the landed elite happy with the coffee support schemes and placate the
new commercial and industrial bourgeoisie with more favourable conditions for industrialisation. A similar change
occurred in Argentina. Again in 1930 a military coup was engineered, and ultimately after struggles between
extreme nationalists and more liberal factions within the military, the generals attempted to balance the needs of
the commercial and landed elites. Neither country had either the political structures or the economic policies to
pursue full-blooded ISI before 1939, but the Second World War weakened the agricultural exporters in both
countries.
The Second World War cut the Latin American countries off from their exporters more decisively than
had the First. The situation was redeemed to some extent by much greater interest by the USA in obtaining Latin
American supplies of strategic products, but also by greater co-operation between the Latin American countries
themselves. They began to conceive of internal Latin-American economic co-operation and a common market for
the continent. The huge fall in imports from Europe led to much more extensive efforts, with backing from US
technical personnel, to develop industry further. The scarcity of capital and expertise was a major problem but the
larger countries began to pursue industrialisation much more deliberately and laid the transition to full ISI in the
1950s. In all Latin American countries, the state was forced to undertake a more vigorous role in production and
organisation of the economy, with the result that budget deficits and inflation increased. Ordinary workers bore the
brunt of inflation, as they could not protect their wages against the rapid rise in the price level. The balance of
payments did not suffer, because the USA was a pretty voracious buyer of some lines of Latin American exports,
and the flow of imports was cut by the war. So the major Latin American economies managed to build up their
reserves of foreign currencies during wartime, but this left problems for the postwar period – how could inflation
be brought under control? Would the US role in South America continue? Could trade between the Latin American
states be sustained? Would Japan and Europe reconstruct their manufacturing sectors, and what would their
approach to Latin American markets be after the war?
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